DéJà Vu

A major Wall Street firm is accused of misleading clients by concealing key conflicts of interest. E-mails suggest that an employee touted its wares in public while slamming them in private. The scandal is front-page news, and observers anticipate severe damage to the firm’s reputation. We could be talking about Goldman Sachs today. But we could also be talking about Citigroup or Merrill Lynch in 2002, after the tech bubble burst. Then there was widespread anger at banks’ dodgy practices and reckless behavior, and an insistence that investors and regulators needed to be more vigilant. So why are we going through this all over again?

In the middle of the past decade, it seemed as if Americans thought that Wall Street could do no wrong. But just a couple of years earlier people thought that Wall Street could do nothing right. High-profile analysts had put “buy” ratings on the stocks of companies that they privately called “pigs.” WorldCom and Enron committed outrageous accounting fraud, the latter abetted by the venerable Arthur Andersen. There was so much bad behavior that it was hard to keep track—I.P.O. spinning, mutual-fund late trading, Adelphia, Tyco. There was shock that companies whose viability depended on reputation had so casually exploited their clients, and a sense that it would take a long time for the banks to win back trust.

If only. The post-bubble backlash gave rise to useful new regulations, but it had no discernible impact on Wall Street’s actual business. The very year that the analyst scandal broke, investors gave major offenders like Citigroup and Merrill Lynch more money to manage. Within a few years, financial-industry profits were at an all-time high. Will investors forgive as easily this time? “The rational part of my brain says that after something like the Goldman thing no one will want to do business with them in the future,” Barry Ritholtz, an asset manager and the author of “Bailout Nation,” says. “But the experienced part of my brain says that nothing significant is going to change.” Goldman, at least, can point to a track record of enormous success, but even terrible performance doesn’t always drive customers away. Ritholtz points to Merrill. Its advice helped bankrupt Orange County, in 1994. Its clients lost huge sums during the Internet bubble. And it lost more than fifty billion dollars in the credit crisis. Yet plenty of people still trust it with their money. Ritholtz says, “It’s like what Hegel supposedly said: The only thing we learn from history is that we learn nothing from history.”

Why the amnesia? Greed is part of it. Easy money, which the housing bubble seemed to promise, put people in a forgiving mood. Investors’ losses during the technology bubble also had the paradoxical effect of making them need Wall Street more: they wanted high returns in order to make up what they’d lost. Just as gamblers who are down keep returning to the casino (it’s called “chasing losses”), state pension funds and nonprofits that had lost a bundle in the tech bubble were among the most aggressive investors in the risky parts of the subprime swamp.

Oddly, tougher disclosure requirements may also have made it easier for investors to think that things had changed. These days, presentations and offering documents are stuffed with warnings and risk disclaimers. The flipbook for the deal at the heart of the current Goldman Sachs scandal warned that it might not contain all material information, offered no guarantee that the information was accurate, and said that there were “potential conflicts of interest” in the deal. It might as well have said “Don’t trust us.” The problem, as George Loewenstein, an economics professor at Carnegie-Mellon, has shown, is that we tend to discount disclosed conflicts of interest and, in general, underestimate their importance.

Ethical issues aside, the banks also did poorly at their core job, which is managing risk. And, while there are plenty of honest, capable people in finance, the ease with which investors looked past Wall Street’s failings seems like a classic case of what the social psychologist Leon Festinger called “cognitive dissonance.” Festinger argued that when beliefs come into conflict with reality we think up explanations that shape reality to our beliefs, rather than vice versa. He used the example of the Millerites, a millenarian religious sect that came to believe that Jesus Christ would return to earth on October 22, 1844. He didn’t. But not all the Millerites abandoned their faith. Many set about constructing elaborate rationalizations to justify their belief, arguing that Christ had returned spiritually, or that the event had occurred in Heaven, if not on earth. Similarly, when people’s faith in Wall Street as an honest broker, a smart allocator of capital, and a path to personal wealth was disappointed, they managed to explain things away.

This pattern of disappointment and renewed faith in finance isn’t new. But the cycles have been speeding up. After 1929, it took three decades before Wall Street seemed safe again, and there was almost a decade between the scandals of the nineteen-eighties and the boom of the late nineties. By contrast, the backlash after the tech-stock bubble burst lasted barely a couple of years. That’s a good argument for passing the financial-reform legislation currently in front of Congress—before investors suffer another bout of amnesia. As President Obama said last week, we need to “learn the lessons of this crisis, so we don’t doom ourselves to repeat it.” Maybe this time we can remember not to forget. ♦

Sign up for the daily newsletter.Sign up for the daily newsletter: the best of The New Yorker every day.